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Tucows Inc. (TCX)

Q3 2007 Earnings Call· Tue, Nov 6, 2007

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Transcript

Operator

Operator

Good afternoon, ladies and gentlemen. Welcome to Tucows Inc.’sthird quarter fiscal 2007 results conference call. (Operator Instructions) Iwould now like to turn the call over to Leona Hobbs, Director of Communicationsfor Tucows Inc. Please go ahead, Ms. Hobbs.

Leona Hobbs

Management

Thank you, Operator. Good afternoon, everyone and thank youfor joining us for today’s call. With me is Elliot Noss, our President and ChiefExecutive Officer; and Michael Cooperman, our Chief Financial Officer. Earlier this afternoon, Tucows issued a news releasereporting the company’s results for the third quarter of fiscal 2007 endedSeptember 30, 2007. The news release and other information for investors isavailable by going to about.tucows.com and clicking on investors. Before we begin today, I would like to point out that thematters we will be discussing include forward-looking statements and as such,are subject to risks and uncertainties that would cause actual results todiffer materially. These risk factors are described in detail in our documentsfiled with the SEC; specifically, the most recent reports on Form 10-K and10-Q. We urge you to read our securities filings for a fulldescription of the risk factors applicable to our business. I would now like to turn the call over to Elliot.

Elliot Noss

Management

Thank you, Leona. Good afternoon and thanks for joining ustoday. For today’s call, I’ll begin with an overview of our performance andsome of the highlights from the third quarter. Mike will then provide adetailed review of our financial results, and I’ll close the call with adiscussion of the significant growth opportunities in front of us beforeopening the call up to questions. Let me begin with the financial highlights for the quarter.Cash flow from operations remains solid at $2.3 million, marking our 24thconsecutive quarter in positive territory, subject to the caveats I’ve discussedon previous calls. At the bottom line, adjusted net income was $1.1 million andwe incurred a net loss of $300,000. However, this does not include roughly$250,000 of integration costs following the IYD transaction. Revenue for the quarter grew 6% to $17.8 million compared tothe third quarter of last year. Despite the price decrease in traditionaldomain names and challenges around advertising revenue, which I will discusslater. Now, let me dig into the quarter in a little more detail.I’ll begin with our traditional domain registration business. As we discussedlast quarter, we made a strategic decision to implement a significant pricereduction on wholesale domain names, which we believe was the right thing to dofor the business over the long term and that we expect will bring backincreased growth, certainly in terms of units, but also likely in terms ofdollars. We knew when we did this that it was something that would bevery expensive in the short term but that the return over the long term wouldbe worth it. Early returns on that decision have been positive. We have seen an increased level of new customer sign-ups.They are up 15% compared to the third quarter of last year and up 55% comparedto the second quarter of this year. In addition, our renewal rate…

Michael Cooperman

Management

Thanks, Elliot. As Elliot discussed earlier, the thirdquarter was another in which we achieved positive cash flow from operations. Itwas also one in which our results were dampened by a number of factors,including the impact of the price reduction on wholesale domain names and thedeclining yields from our Google ad feeds, which as we indicated last quarter,has had a short-term impact on both our top and bottom lines. Net revenue for the third quarter was $17.8 million, anincrease of 6% from $16.9 million for the corresponding quarter of last year.Net revenue from domain names and other Internet services increased by $1.2million, or 7% to $16.7 million from $15.6 million for the same quarter in2006. Revenue from domain registrations increased 9% to $12.3million, from $11.3 million and accounted for 69% of total revenue compared to67% for the third quarter of last year. While growth has been impacted by the price reduction in theshort-term, we do believe that we have better positioned this business forlonger term growth. Revenue from other Internet services increased by 3% to $4.4million from $4.3 million for the third quarter of last year, and represented25% of total revenue, down marginally from 26% for the third quarter of lastyear. Revenue from advertising and other content service sourcesfor the third quarter was $1.1 million compared to $1.3 million for the samequarter last year. As Elliot commented earlier, these results weredisappointing and were impacted by the declining yields from our Google adfeeds and, to a lesser extent, the decline in advertising revenue from theTucows software libraries. Advertising and other revenue as a proportion of total revenueincreased to 6% from 8% for the same quarter last year. Cost of revenues, including network cost for the thirdquarter, increased by 19% to $13.4 million from $11.2 million for the thirdquarter of last year, primarily…

Elliot Noss

Management

Thanks, Mike. While we experienced some challenges that havesoftened our growth in the short-term, when looking at the evolution of ourbusiness throughout 2007 and where we are right now, I can’t help but be veryoptimistic about our future. We have a historical domain registration businessthat provides us with a good base of revenue, margin, and customerrelationships, and we have significant growth opportunities before us in ournon-traditional domain names and our hosted e-mail businesses. As noted in today’s press release, we now expect to generatebetween $8.5 million and $9 million this year in cash flow from operations.This is due to the softness in traditional domain names in the second quarter,the depressed advertising revenue I mentioned earlier, and the additional costsassociated with a more cautious approach to system migrations. This is not what we had hoped. This business is, the Tucowsbusiness is and has historically been very predictable and very reliable. Webelieve this is still the case and that the future holds great promise. With traditional domain names, we talked about some of thepositive indications we are seeing from our recent actions. I truly believethat this is the best that I have felt about the traditional domain namebusiness and our ability to make gains going forward since 2002 or 2003. It isthe case that we are starting to play offense again and doing so with a veryclear understanding as to how the traditional domain name business feeds thetwo high growth areas in the company. With respect to non-traditional domains, we have onlyrecently been provided with the opportunity to start to engage additionalpotential sources of supply. Some of you may have noticed that one of ourpartners, NameMedia, filed for an IPO last year. Their filing providesinvestors with a better look and a deeper understanding of the business ofselling premium domain names. Investors will…

Operator

Operator

(Operator Instructions) Your first question comes from ThanosMoschopoulos of BMO Capital Markets. Please go ahead.

ThanosMoschopoulos - BMO Capital Markets

Analyst

Elliot Noss

Management

You wouldn’t see it there because customers would sign upand we wouldn’t have parsed that for, you know, what other transactions thatthose new customers have done. That would just be a slice of the data wewouldn’t have this early in terms of the results.

Thanos Moschopoulos -BMO Capital Markets

Analyst

And the reduced pricing wouldn’t necessarily drive -- itwouldn’t change end customer transaction volumes because your partners wouldkeep pricing the same, [you would just get] the benefit, presumably?

Elliot Noss

Management

Well, we do think that this may have been one of the thingsthat positively impacted on renewal rates. So in other words, the -- ourworking model is that some of our customers did choose to get a little moreaggressive on price and hopefully there lose less customers to some of thecompetition.

Thanos Moschopoulos -BMO Capital Markets

Analyst

Okay, but in terms of actual transaction volumes, what didthat do year over year?

Elliot Noss

Management

We’ll dig that up for you.

Thanos Moschopoulos -BMO Capital Markets

Analyst

Okay. I guess while you’re digging that up, can youelaborate a bit further about the strategic changes you’ve made on the adbusiness as far as bringing on new suppliers? I mean, is it a situation wherebasically we can expect the yields to keep declining and you’ve managed toreduce the slope at which that occurs? Or do you think they might stabilizenow? Might there be actually some upside now that you’ve got some new partnerson board?

Elliot Noss

Management

I want to make sure that I separate two things there. One isthe ad revenue around direct navigation and the other is the ad revenue aroundthe traditional Tucows.com software libraries. When we’re talking about new suppliers, that’s as it relatesto direct navigation. So there, one of the things that we were not able to takeadvantage of fully in our previous relationship was the ability to optimize.And we will immediately -- and we have very, very early returns and they arequite positive. So we are now seeing click-throughs increase materially andthat drives revenue. We’ll convert that into yield data again probably atmonth-end. The new relationship started in November, but when I’m talking aboutthose depressed Google yields, those are something we are seeing across theindustry with smart pricing and quality scores, and you may have heard thatdiscussed in some other forums. For us, as it relates to the direct navigation business, Iwant to make sure that I separate these two things, we think that the newsupplier relationships will lead to a near-immediate turnaround and a return togrowth. With respect to the historical Tucows.com business, wereally need to take a step back and figure out what next steps to take. Again, I’m very encouraged on the direct navigation side.

Thanos Moschopoulos -BMO Capital Markets

Analyst

Okay, and presumably -- so as far as the existing Tucowsbusiness, that the yields wouldn’t go up there under new suppliers, just as afunction of how that operates?

Elliot Noss

Management

No, because when we’re looking for new suppliers, that’s inthe direct navigation business. Remember that what those people are experts atis at optimizing a parked page, a direct navigation page. When you are dealingwith something on the content side, that’s the straight AdSense for search orAdSense for content feed. It’s just a typical, kind of ads by Google box yousee on a page.

Thanos Moschopoulos -BMO Capital Markets

Analyst

I guess it’s kind of early to say, given that it happenedfairly recently, but what impacts if any are you seeing from the recent increasein ICANN fees?

Elliot Noss

Management

Sorry, could you repeat it?

Thanos Moschopoulos -BMO Capital Markets

Analyst

The recent increase in the registrar fees, what impact ifany are you seeing as far as the transaction volumes and so forth? Has that hadan impact on the industry?

Elliot Noss

Management

You know, I’ll be very interested. I’ll be with a bunch ofpeople in the industry next week at an event. We got out -- from ourperspective, we got out in front of that. We insulated ourselves with both thechange -- with both the drop in price and the change in pricing methodology, sofor us, thankfully that was business as usual. Now, you know that we did kindof pay the price for that and we’ve talked lots about that, but we do thinkthat we are now insulated from that going forward. I’ll be very interested to hear next week what others in theindustry are saying. Transactions, Q306 about 1.2 million; Q307, up to 1.4million.

Thanos Moschopoulos -BMO Capital Markets

Analyst

Okay. And I guess turning to something topical, the Canadiandollar, can you talk about -- remind us of your current forward position andthen I guess heading into ’08, how are you going to deal with the big increasewe’ve had in the currency?

Elliot Noss

Management

We were hedged -- we are hedged through the end of ’07.That’s a hedge we put in place in November of ’06, and so it was veryfortuitous. I think us, like a lot of Canadian exporters, are going naked into’07. I think that what that’s led us to do -- you know, this isn’t news andwe’ve seen this coming, obviously, for the last number of months, and so we’vehad to be a lot smarter in the way we think about op-ex. We think that it’s ledto a lot of really good thinking and we don’t think it’s going to stand in theway of achieving real growth next year. We’re naked.

Thanos Moschopoulos -BMO Capital Markets

Analyst

Okay. But I guess -- does that mean that heading into nextyear, are you going to have to do some cost rationalization or just kind offocus on growing while maintaining a very tight leash on your existing costs?

Elliot Noss

Management

Well, I think that we -- we have already thought throughthose issues and I think that if you look at our op-ex lines, they are prettyimpressive in terms of cost control. We think that that is not only going tocontinue but get better through next year.

Thanos Moschopoulos -BMO Capital Markets

Analyst

Okay. Now, Google a few months back entered your space asfar as providing services to service providers. Have you been seeing them atall or are they not really pursuing it in a big way from your perspective?

Elliot Noss

Management

We have been seeing little tiny bits around the margins. Sowe have seen them in one or two customers poking at it, but frankly in the lastthree or four months, we haven’t seen much. We really think that their big pushthere will be at enterprise. Believe me, we are keeping our ear to the groundand our eyes peeled, but at the end of the day, they would be much moreeffective working through somebody like us than against us.

Thanos Moschopoulos -BMO Capital Markets

Analyst

Okay, and can you dig a bit more deeply on the e-mailbusiness? You talked about how there are long sales cycles there, you are nowgetting towards the tail end of it. As you start to close business there, is itgoing to be a slow and steady ramp or is it a situation where you have somelarge deals in the pipe and it might be sort of lumpy growth, a step functionas you sign some of these?

Elliot Noss

Management

There’s always a couple of large opportunities in the pipe,but we certainly are planning around slow and steady growth. We’ve started towrite some business now. We’ve started to deal with incoming new customers.There’s a new spring in the step around the sales group. I think that they have been, as I’ve talked in the past, toa great extent parked in the garage for a long period of time and they arequite happy to be out there hitting it again. And it shows. It is just -- I mean, it’s a pleasure to see and so I thinkwe will get back to growth and we fully expect ’08 to be a very good year forgrowth in hosted e-mail.

Thanos Moschopoulos -BMO Capital Markets

Analyst

Okay. All right. Thank you. I’ll pass the line.

Operator

Operator

Your next question comes from Steven Wolfe of PlatinumPartners. Please go ahead.

Steven Wolfe -Platinum Partners

Analyst

I wanted to get your thoughts on some of the new businessopportunities, certainly e-mail and premium names being the first real quarterthat you’ve seen some of that business now. Can you give us a little bit ofinsight as to qualitatively, what you saw in the quarter and what your thoughtsare for the next couple of quarters in that business?

Elliot Noss

Management

Sure, and again, I think e-mail, I’d repeat what I just saidwhere the guys are out pitching again. They have started to write business,bringing home some meat back to the cave and I think that’s what sales guyslove to do, especially good ones. And you know, they are much happier becauseof it and of course, we are too, so we are feeling like we are on our waythere. In terms of premium names, it’s really -- it’s exceeding expectations.We are seeing all phases of this market evolve and evolve rapidly. Steven, Iknow you would like to dig into detail. I’d really encourage you to go checkout the NameMedia filing. There’s a lot of juicy information in there and it’sreally the first time publicly that people have been able to see some of thatinformation. There’s just great little stories on a weekly basis.Additions to our inventory, this quarter we for the first time sold some of ourown names through the premium marketplace. We are working with customers aroundtheir integrations there and around driving look-ups. There’s just a ton oflearning going on there. It’s become a very real part of this business and onethat’s really sprung from whole cloth if you go back to 2006.

Steven Wolfe -Platinum Partners

Analyst

Certainly asset wise, I mean, you have 8 million domainnames under management. How does that compare with some of the other folks inthe industry?

Elliot Noss

Management

There we’re -- I think we’re still slightly in fourth, maybestarting to chase third there, but what’s important is that the folks that arebigger than us there generally, and I think it’s true for most of the top sixor eight registrars, they have chosen to monetize their expiry stream throughauctions. Now, that choice will always make you more money in theshort run because what you have is essentially wholesalers, people likeNameMedia, looking through those options for buying opportunities that they canthen sell at retail. In other words, sell to a small business who is looking tostart up and get a domain name. We are now seeing the opportunities around selling to someof those business start-ups directly and it’s -- the difference between sellingat wholesale and selling at retail is three and four and sometimes 10 times. Sowe think that the asset that we have, as far as registrars go, is unique, atleast in terms of the way that people talk about their policies. Some people may have been doing some things surreptitiouslythat we wouldn’t know about and maybe their customers don’t know about, but tothe best of our knowledge, we’re the only ones who have built up this asset.

Steven Wolfe -Platinum Partners

Analyst

All right, well, great.

Elliot Noss

Management

I should note, remember that’s on top of the asset containedin our surname portfolio and in the premium names that we picked up in theNetIdentity transaction.

Steven Wolfe -Platinum Partners

Analyst

Understood. Well, great. Thanks for the call.

Operator

Operator

(Operator Instructions) Mr. Noss, there are no furtherquestions at this time. Please continue.

Elliot Noss

Management

Thank you, Operator and I look forward to speaking with allof you again on our next call.

Operator

Operator

Ladies and gentlemen, this concludes the conference call fortoday. Thank you for participating. Please disconnect your lines.